When You Least Expect It

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There can be few fields of human endeavor in which history counts for so little as in the world of finance. Past experience, to the extent that it is part of memory at all, is dismissed as the primitive refuge of those who do not have the insight to appreciate the incredible wonders of the present.

- John Kenneth Galbraith

A few minutes after 10am EST Friday morning the Dow hit 14,000. The previous Friday, the S&P closed above 1500. Two Saturdays ago, The New York Times ran a front page story about small investors returning to the market. “I just bought some more stock this morning [Friday],” said Jim Cole, a 52 year old employee at The Bank of the West in San Francisco. “There doesn’t seem to be this swirl of impending doom hanging over the US economy or the world economy looking out 6 to 12 months from now.”

Small investors aren’t the only ones becoming more bullish of late. B of A/Merrill Lynch’s January survey of professional money managers showed them as bullish as any other time during the current bull market. A net 59% expect the global economy to strengthen this year, the highest reading since April 2010. “Following the resolution of the US fiscal cliff, sentiment has surged,” said Michael Hartnett, Chief Investment Strategist at B of A/Merrill Lynch. “Half of investors now tell us that they would sell government bonds to buy higher beta stocks, which is consistent with our call for a “Great Rotation” to start in 2013.”

I could cite countless other facts showing the same thing: the VIX at 13, junk bond spreads, short interest, etc… The sentiment of the global economy’s elite in Davos last week is that we have escaped the shadow of the 2008 financial crisis. “I was riding around in a van last night with two guys whose names you’d recognize,” Scott Minerd, CIO of Guggenheim Partners in Santa Monica told Bloomberg BusinessWeek. “They were comparing notes and hearing the same thing. The conclusion has sort of gone viral. There’s a crystallization of thought that the financial crisis is over.”

In my last Client Note, I wrote about the one stock that is not working in the current environment: Apple (AAPL). A stock that is working and is in certain respects the opposite of Apple is Facebook (FB). While Apple has declined from $700 to $450 in recent months and now trades for about 7 times earnings, Facebook has climbed from $20 to $30 and trades for about 50 times earnings.* This is just another example of how out of whack the current market is.

The paradox of financial markets is that this sort of sentiment is highly correlated with market tops. When everybody least expects it, that’s when the bottom tends to drop out. That’s because the market is a reflection of mass psychology in the form of supply and demand. It is my belief that the bull market which began in March 2009 is on the verge of ending.